In 2015 the government announced a specific tax regime in order to tackle the problem of disguised investment management fees.

This is a freeview 'At a glance' guide to the taxation of performance-linked rewards paid to asset managers.

Performance-linked rewards paid to an individual performing investment management services are charged to tax as income. 

  • The measure aims to ensure that investment managers are taxed appropriately in light of the underlying activity of the investment vehicle and that asset.
  • It applies for periods of account beginning on or after 6 April 2016.
  • This followed a consultation, 'Taxation of performance-linked rewards paid to asset managers'.
  • The tax paid by managers of Collective Investment Schemes (CISs) has historically depended upon the type of reward they receive. 

In Autumn Budget 2017 the chancellor announced immediate removal of the transitional commencement provisions for asset managers under these rules.  

Carried interest definition

Due to an agreement between HMRC and the British Private Equity & Venture Capital Association (BVCA), receipts of ‘carried interest’ by individuals involved in investment management for private equity firms are subject to Capital Gains Tax (CGT) rather than Income Tax. Managers have not unnaturally preferred capital gains treatment on their income and HMRC realised that some changes were required.

Carried interest is statutorily defined by s.809BZE Income Tax Act 2007 (and not Statement of Practice D12) from 8 July 2015 onward, for the purpose of considering whether a payment is, in reality, a management fee (and so chargeable to Income Tax).

Partnership arrangements

Historically it had been possible to use a partnership structure, together with HMRC’s published Statement of Practice D12 to secure a deduction from proceeds such that the amount subject to tax is lower than the amount actually paid to the individual; a practice known as 'base cost shifting' whereby partners deducted the base cost of their investors when computing the capital gain they had realised from their carried interest.

Changes were made on 8 July 2015 to prevent this.

Performance-linked rewards

Changes were made in Finance Act 2016 to ensure that performance-linked rewards are taxed as income and not Capital Gains Tax (CGT). The measures apply from 6 April 2016.

  • Previously, there were no special tax rules specific for the asset management sector to determine whether managers’ performance-linked rewards should be treated as capital in nature.
  • Applying normal investment/trading principles to the activities undertaken by a typical fund can be difficult and resource-intensive, can result in inconsistent treatment of managers who are carrying out broadly similar investment activity and be exploited by taxpayers seeking to use the uncertainty in the system in order to access preferential tax treatment.
  • The 2016 changes introduced statutory tests to set out, and thereby clarify, the circumstances in which performance fees arising to fund managers from their fund management activities may be treated as capital in nature.
  • The rewards will be taxable as income unless the underlying funds that they manage hold their investments for a period of time if, on average, the investments are held for more than 40 months then the rewards will be treated as entirely capital, if they are held for a shorter period, an increasing proportion of the rewards will be treated as income instead.
  • Different calculation rules will be introduced for the various asset classes, including venture capital and real estate.
  • These tests will not affect the tax treatment of investors in the funds.

The rules only apply to the performance-linked rewards paid to investment managers. They do not apply to any genuine co-investment in the fund made on the same terms as those made by third-party investors. It will also have no impact on the treatment of the investment vehicle or investors.

This is a specialist area and expert advice should be taken accordingly.

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